3.4 Market structure Flashcards
what is economic efficiency?
optimal allocation of scarce resources to help satisfy changing wants and needs
what is allocative efficiency?
when the cost people are willing to pay is the same as the cost the good costs to make - market cost = marginal cost of production,
AR=MC
what is productive efficiency?
when firms have reduced costs so they aren’t wasting resources and so is operating at the lowest point on the cost curve = this occurs when AC=MC
(all economies of scale are exploited)
what is dynamic efficiency?
when a business successfully meets the changing needs and wants over time
- depends on if markets has rapid innovation
what is social efficiency?
same as allocative efficiency, when MSB=MSC
- because of negative externalities that the firm ignores it is not producing at the socially optimum point
what’s creative destruction?
idea proposed by Joseph Schumpeter, dynamic efficiency causes innovation which causes some jobs to be lost while others are made like how new production units replace old ones = overall a good things
what’s deadweight loss of welfare?
a loss in producer and consumer surplus due to an inefficient level of production
whats pareto optimally?
someone will always be worth of as a result of trade
whats X-inefficiency?
a lack of real competition, often faced by monopolies, so they don’t have an incentive to invest in consumer welfare or production which can lead to inefficient production and high costs
whats is a perfectly competitive market?
a market structure where assumptions are strong ➡️ unlikely in real world, used to compare to imperfect competition
examples - farmers
what are the characteristics of a perfectly competitive market?
- identical/homogenous products
- all firms have same access to factors of production
- no barriers to entry or exit
- perfect knowledge by everyone
- large number of buyers and sellers who act independently
- economic assumptions ✅
- firms are price takers, no control over price of product
when can profits be made in a perfectly competitive market?
in the short run, supernormal profits can be made as the price’s set by the demand
but
in the long run, can only make normal profits, this is because the supernormal profits attract new firms into the market which causes an outward shift in supply and every firm is making normal profits where AR=AC (these firms will then leave the industry causing market supply to shift inwards
efficiency in perfect competition?
allocative efficiency (P=MC) is achieved in both short and long-term
❌
- dynamic efficient as homogenous products + lack of supernormal profits means firms can’t invest
why are competitive markets good for the economy?
- lower prices because of many competing firms
- entry of new firms increases competition, keeping prices low
- lower profit margins than monopolies
- greater entrepreneurial activity
- high productivity +. avoid x-inefficiency
why can perfect competition not happen in the real world?
- most firms have some sort of price-making power
- always differentiated/ branded products
- always info gaps for customers
- patents/ regulations etc
- assumes there are no externalities
evaluation of perfect competition?
✅
- consumers aren’t exploited in terms of price
- consumers can all buy the same product
- no wasted costs in terms of advertising
❌
- consumers don’t have much choice
- firms are unlikely to be able to grow large enough to benefit from economies of scale
what is monopolistic competition?
imperfect market structure, similar to perfect competition but more realistic as firms have some price setting power
what are the characteristics of monopolistic competition?
- many buyers and sellers
- imperfect knowledge
- low barriers to entry and exit
- slightly differentiated products
- economic assumption ✅
- firms have little price-making power
when can profits be made in a monopolistically competitive market?
- in the short run supernormal profits can be made, these supernormal profits paired with lack of entry barries causes new firms to enter the market ➡️ demand curve for existing firms shifts left as consumers buy new firms products (until AR curve in tangiable to the AC curve)
- in the long run the firms is at is profit-maximising output as MR=MC but is also only making normal profits
to what extent does monopolistically competition lead to economic efficiency?
❌
allocative efficiency as prices are above marginal costs
productive efficiency as due to the saturation of the market businesses cannot fully exploit economies of scale
socially inefficient due to negative externalities of packaging etc
✅
dynamic efficiency, consumers have lots of choice so have to innovate
what are the non-price strategies used by monopolistic competitive markets?
- online availability
- more sizes
- customisation of the product
- return policies for customers
- use of social media
what are the characteristics of an oligopoly?
- top five firms dominate over 60% of the market
- high barriers to entry and exit
- lack of knowledge
- economic assumption ✅
- high level of market concentration
- each firms supplies branded products
- independent strategic decision making
what is strategic independent decision making?
the actions/decisions/pricing of one firms are influenced by the likely action of competitors
- always a high level of uncertainty
what is the concentration ratio?
- ratio of the size of the firm to the industry
- it measures the combined market share of the top ‘n’ firms
- if the 5-firm concentration ratio is greater than 60%, then we have an oligopoly
is there normally collusive or non-collusive behaviour in an oligopoly?
non-collusive
- idea that firms do not work together and instead they will compete with each other
- collusive behaviour can be deemed illegal if they do not improve production, innovation of consumers’ experience
collusive
- businesses in a cartel recognise their interdependence and act together (aim to maximise profits)
- lowers the costs of competition eg advertising
- reduces uncertainty
- good when price inelastic demand
- firms have to trust eachother
➡️ happens when there are low regulators or penalties on collusive behaviour
why do price fixing cartels often break down?
- recession
- entry of non-cartel buisness
- over production within the cartel
- whistle-blowing firms (snitches)
cost of collusive behaviour?
- damages consumer welfare ➡️ higher prices, loss of allocative efficiency, hits poorer more
- the absence of competition effects efficiency
- reinforces the cartels monopoly power
possible benefits of collusive behaviour?
- stablity with prices
- profits have value, how are they used
winners and losers of price wars?
winners
- consumers
- managers who may get better bonuses
losers
- shareholders if prolonged price wars lead to lower profits
- suppliers if monopolies use their size
- smaller firms who can’t absorb the effect of low prices
- the govt. is lower profits cause a decline in corporation tax
what’s limit/penetration pricing?
setting a low initial price to deter entry or the expansion of fringe firms to short run profit maximise (but above the competitive level)
characteristic of a monopoly?
- a single supplier who dominates the market
- working monopoly = over 25% of market total sales
- dominant firm = has 40% of market share
- Price-making power
- high entry and exit barriers
- economic assumptions 👌
- if AR is falling MR will fall twice as steeply, have to reduce price of all units not just one additional unit
what is a natural monopoly?
when a large business can supply a market at a lower price than smaller ones ➡️there cannot be a more efficient provider of the good
what is price discrimination?
when a business charges different customers different prices for the same product
- 3rd degree discrimination = charging different prices to groups of consumers segmented by price elasticity of demand, income,age, sex
➡️ firms must have monopoly power, identify different market segments, prevent re-sale
evaluation of price discimination?
✅
- lower prices for some who otherwise cannot afford it increases market share
- more profits can result in higher dividends
- businesses can make better use of spare capacity
❌
- increase regional inequality
- increase in admissions cost
- grouping of consumers is not perfect
depends on
- extent of its used
- depends on how buisnesses choose to use their profits
- difficult to find fair price
economic efficiency of monoply?
- X-inefficiency ➡️ productive efficiency + price
- fewer economies of scale
- monopoly may get too big
what is a monopsony?
a firm with buying or bargaining power in their market (singlebuyer)
- this power can be exploited by forcing suppliers for lower prices
eg
- supermarkets
- British sugar market
- amazon
- govt - NHS, military
benefits to firms of a monopsony?
- allows bigger firms to achieve purchasing economies of scale leading to lower long-run average costs
- lower purchasing costs would cause higher profits and increased returns for shareholders
- extra profit can be reinvested
benefits to consumer of a monopsony?
- can gain from lower prices if passed onto product price
- improved value for money eg NHS can use its bargaining power to cut the prices of drugs used in treatment
drawbacks from monopsony powers?
- reduced profits from firms in the supply chain (eg milk farmers battling to get higher prices from supermarkets to cover average costs)
- less choice or higher markets if some suppliers are forced to leave the market
what are the characteristics of a contestable market?
- low barries to entry and exit, allowing new suppliers to come in and make more competition
- perfectly contestable = entry and exit costless
- common when there is one or more dominant business
characterised by the threat of competion
eg - fast food
- bookselling
conditions required for market contestability?
- a pool of new businesses who are willing and ready to enter the market
- no sign. entry or exit costs
- equal access to industry technologies
- high rates of customer switching (low brand loyalty)
